In this OnPoint, we discuss new rules announced by China’s Ministry of Commerce (“MOFCOM”) aimed at counteracting the extraterritorial impact of foreign law on Chinese persons. While the timing and current geopolitical context seem to indicate that these rules are squarely aimed at the long-arm application of US (secondary) sanctions and export bans against Chinese entities, they do not expressly mention U.S. law and in many respects follow similar EU rules.¹ Broadly speaking, however, Beijing’s adoption of a new blocking mechanism will challenge the U.S. sanctions and export control regime globally and presents compliance complexity for companies operating between the two countries.

On 9 January 2021, MOFCOM issued its first order of the year: Rules on Counteracting Unjustified Extra-territorial Application of Foreign Legislation and Other Measures (“Blocking Rules”), establishing a mechanism to counteract the reach of foreign legislation on Chinese persons.² While the Blocking Rules took immediate effect,³ they do not yet indicate specific foreign measures to which the rules will apply. This is unlike similar EU rules which include an appendix of the laws, regulations, and other measures subject to blocking.⁴ Therefore, the Blocking Rules provide broad discretion to Chinese authorities but likely await further specification before their full enforcement.

Scope and Application

The Blocking Rules apply to the extraterritorial effects of laws and measures imposed by a foreign country or region (not those adopted via international treaty or by the United Nations)⁵ unjustifiably prohibiting or restricting the citizens, legal persons or other organizations of China (“Chinese Persons”) from engaging in normal economic, trade and related activities with a third state (or region), its citizens, legal persons or other organizations.⁶ Although not explicitly stated by MOFCOM, the Blocking Rules appear to apply to controls on third country re-exports as well as secondary sanctions, and thus do not appear to be intended to directly cover primary sanctions (direct bans or restrictions between a sanctioning country and the sanctioned country) or direct exports from the United States.⁷ At the same time, the text of the Blocking Rules does not rule out the possibility that primary sanctions may also be covered. We expect the scope of the Blocking Rules will be further clarified in the course of future enforcement actions and/or by implementing rules.

Under the Blocking Rules, a “Working Group” comprising multiple Chinese ministries (led by MOFCOM), with input from the National Development and Reform Commission (both sitting under the State Council),⁸ is empowered to assess and determine whether there exists unjustified extraterritorial application of foreign law and other measures by taking into consideration three factors:

1. Whether international law or the basic principles of international relations are violated;
2. Potential impact on China’s national sovereignty, security, and development interests;
3. Potential impact on the legitimate rights and interests of the citizens, legal persons, or other organizations of China; and
4. Other factors that shall be taken into account.⁹

Particularly in light of the catch-all provision in clause 4, it is apparent that the Working Group has an extremely wide berth in the scope of its interpretation and ultimate decision-making powers.

It remains unclear whether the China-based subsidiaries, branches and joint ventures of foreign companies are subject to the Blocking Rules as Chinese Persons. Arguably, however, these are organizations of China and therefore captured by the Blocking Rules. This would present significant challenges to U.S. companies operating in China and impose reporting requirements (see below).

Blocking Mechanism & Exemptions

Where it is determined by the Working Group that there exists unjustified extraterritorial application of foreign law or other measures based on the above factors, MOFCOM may issue a “Blocking Order” nullifying the relevant foreign measure(s). For example, Chinese authorities could block application of a U.S. sanction or re-export restriction that applies to the conduct of third country companies (due to the involvement of a U.S. nexus or products subject to U.S. jurisdiction). In so doing, this would permit an aggrieved Chinese Person to seek damages in domestic Chinese court against a company complying with the applicable U.S. sanction or re-export restriction. A complying company would need to assess the risks, on the one hand, of domestic Chinese litigation and, on the other, of the consequences of failing to abide by U.S. sanctions and/or export laws. Such penalties might include loss of access to U.S. financial institutions and being added to U.S. government lists of entities subject to sanctions and/or export restrictions.

There is no stated time limit for the Working Group to come to a decision, and Blocking Orders may be suspended or withdrawn by the Working Committee.¹⁰

A Chinese Person may apply to MOFCOM for exemption from complying with a Blocking Order. The application must include the reasons for the application and the scope of the exemption. Decisions on whether to approve the application will be made within 30 days of the date of acceptance of the application and may be expedited in emergency cases.¹¹

Reporting Obligation & Penalties

The Blocking Rules also include a reporting obligation on Chinese Persons to report to MOFCOM within 30 days where they have been prohibited or restricted by foreign law or other measures.¹² Where a Chinese Person fails to truthfully report as required or fails to comply with a Blocking Order, MOFCOM may give a warning, order the person to rectify within a specified period of time, and may concurrently impose a fine according to the severity of the circumstances.¹³

Litigation Risk & Further Remedies

A Chinese Person may initiate legal proceedings in Chinese domestic courts and claim damages for losses suffered due to the compliance of another party with a foreign law or other measure included in a Blocking Order (unless that party has obtained an exemption). This may present serious risks to the assets and reputation of companies operating in China.

State support may also be made available. Where, in adhering to a Blocking Order, a Chinese Person suffers significant losses resulting from non-compliance with relevant foreign laws and measures, the relevant government departments may provide necessary support based on the circumstances.¹⁴

Finally, the Blocking Rules state that the Chinese government may take necessary countermeasures to unjustified extraterritorial application of foreign laws and measures based on actual circumstances and needs.¹⁵ Indeed, the Blocking Rules may well be intended to push back against U.S. export controls, which serve as the key basis for the headline trade bans on several major Chinese tech companies. In this light, the new mechanism would seek to tackle head-on U.S. re-export restrictions by third countries to Chinese Persons.

Further Clarification Needed

As with many Chinese regulations, the language of the Blocking Rules is broad and relatively vague, and there are areas requiring further clarification through enforcement cases and/or implementing rules to be promulgated in the future. For instance, in most cross-border transactions, parties contractually agree to the use of foreign courts or arbitration centers as the exclusive venue for related disputes. In such a scenario, it remains an open question whether the Blocking Rules will prevail over the contractual arrangements chosen by parties with respect to dispute resolution.

In our view, it is too early to predict whether the Blocking Rules are likely to be more of a political gesture (like existing EU rules) or the opening salvo of a substantial enforcement challenge to the operation of U.S. secondary sanctions globally. We expect this will be highly dependent on the policy goals of the incoming Biden Administration and the corresponding impact on U.S.-China relations. Events should begin to move apace following the Chinese New Year holiday this month and as the Biden Administration’s ranks are fully situated in Washington.

Compliance Implications

Companies facing compliance obligations with both foreign sanctions and the Blocking Rules may encounter challenging dilemmas in future. For example, a U.S. company with a Chinese subsidiary may be faced with the tradeoff of complying with U.S. secondary sanctions but running the risk of penalty under the Blocking Rules or vice versa if unable to obtain available waivers or exemptions.

As such, foreign enterprises and their Chinese subsidiaries should consider taking preemptive actions where possible, starting with assessing the level of exposure facing their business lines and assets along with the outlook for obtaining potential waivers from foreign sanctions and/or exemptions from Blocking Orders. Operators would also do well to understand which of their competitors or other third parties are likely to bring related legal actions in Chinese domestic courts and limit local assets exposure accordingly.

Operators may consider establishing a firewall between the foreign parent company and its Chinese subsidiaries and vice versa to segregate control and divide exposure to the risk of being caught up in both foreign sanctions and a Blocking Order. If this approach does not sufficiently mitigate relevant risk, it may be necessary to consider more drastic changes to the corporate structure, such as adjusting the business model to house existing business lines in a third country or with a third party.

Special attention should also be increasingly paid to the inclusion and structure of sanctions and trade compliance clauses in transaction documents. Such clauses will need to be nimbly worded to either effectively capture present sanctions and emerging regimes or limit exposure to discrete measures and how they are applied to parties, their affiliates, and assets.

Conclusion

The Blocking Rules present a credible challenge to the expansion of U.S. secondary sanctions in the past number of years. Taken to an extreme, this new dichotomy will further drive the purported decoupling of U.S. and Chinese economic spheres of influence.

In terms of the practical implications, the breadth and relative ambiguity of the Blocking Rules make clear-cut compliance action difficult to immediately implement. However, the implementation of the Blocking Rules will present serious conundrums to companies operating in both U.S. and Chinese markets, with the potential for high cost trade-offs on the horizon.

Although the Blocking Rules are already in effect, we expect some breathing room before full enforcement takes place (particularly given the lack of detail in both substance and the processes of the Working Group). That said, operators should consider taking proactive measures now with respect to the (re)structuring of their operations and smartly managing exposure in deal-making going forward.

Footnotes

1. Council Regulation (EC) No 2271/96 of 22 November 1996.
2. Order No.1 of 2021: Rules on Counteracting Unjustified Extra-Territorial Application of Foreign Legislation and Other Measures, MOFCOM (9 January 2021), available at http://www.mofcom.gov.cn/article/b/c/202101/20210103029710.shtml (Chinese) and http://english.mofcom.gov.cn/article/policyrelease/questions/202101/20210103029708.shtml (English).
3. Blocking Rules Art. 16.
4. See Annex of Council Regulation (EC) No 2271/96 of 22 November 1996.
5. Blocking Rules Article 15; MOFCOM press release available at http://www.mofcom.gov.cn/article/ae/sjjd/202101/20210103029779.shtml.
6. Blocking Rules Art. 2.
7. See Protecting legitimate rights and interests and safeguarding international economic and trade order - authoritative expert’s answers to reporters’ questions on the Rules on Blocking Unjustified Extraterritorial Application of Foreign Legislation and Other Measures, Today China (11 January 2021), available at http://www.bjinforma.com/zw2018/jj_4978/202101/t20210111_800232241.html.
8. Blocking Rules Art. 4.
9. Blocking Rules Art. 8.
10. Blocking Rules Art. 7.
11. Id.
12. Blocking Rules Art. 5.
13. Blocking Rules Art. 13.
14. Blocking Rules Art. 11.
15. Blocking Rules Art. 12.